AP3 Opportunities out of adversity

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Despite what most in the financial sector would call a truly annus horibilis, the Third National Pension Fund in Sweden, warns against panicking and staring yourself blind on one bad year, particularly as an investor with a long investment horizon. Instead the management of the fund continues to focus on risk management and asset allocation and finding opportunities created by the crisis.

The fund has placed great emphasis on its portfolio composition by reviewing its asset allocation and both long and short-term risk profiles of its traditional asset classes such as equities and fixed income. "The crisis has created new investment opportunities and through our ‘new strategies' we can take advantage of these opportunities, such as price disparities. For instance, we have increased our high-yield exposure by investing in senior bank loans," says Christina Kusoffsky Hillesöy, head of communications and SRI.

Over the past 18 months AP3 has also moved towards alpha/beta separation, which was finalised at the end of 2008. In practice, separating alpha and beta management means a separation of market exposure and active risk exposure. This clarifies the fund's mandate and areas of responsibilities and gives it a better risk profile, improving its chances to add returns. As a result of the change, the fund has terminated some of its fundamental and active external mandates.

Apart from focusing on risk and asset allocation, AP3 continues to be engaged in lobbying for a change in its investment restrictions. "The rules are now outdated and a regular review should be introduced," Hillesöy says. "We believe that the rule stipulating a maximum 5% investment in unlisted assets is too low. This makes it impossible for us to invest in infrastructure which is particularly suitable for pension funds because of its long-term characteristics. The requirement to have 30% invested in fixed income and a prohibition on commodity investments should also be reviewed. The government has said it will look at the regulations but has not stated a timeframe,"

Hillesöy also points out that often the debate about costs in Sweden is skewed. "While costs are important, and our focus is to ensure cost-efficient investment management, what is often forgotten is the relationship between cost and returns. Higher costs can be justified if it adds value. If expected returns are good enough in relation to risk and cost, pensioners will benefit. We hardly ever see this debated."

Beyond investment strategy and cost, the AP funds are all focusing on corporate governance and of late these issues have revolved around remuneration and the bonus debate which was brought to light as a result of the financial crisis, Hillesöy notes. In addition, ethical and environmental issues continue to be at the top of the agenda and, unlike for many other institutional investors, the AP funds have not lowered their level of engagement in these issues because of the financial crisis.